Evaluating how the tariff wars are impacting the U.S. and China economies.
Beginning in early 2018, the Trump administration implemented a series of tariffs on imported goods from China, which have retaliated in kind. These measures have contributed to a slowdown in the U.S., Chinese, and other global economies over the past year. Business confidence and investment have been especially hard hit.
The negative effect on business investment is not surprising. Businesses hate uncertainty, and the trade war has introduced quite a bit of that while also disrupting global supply chains. The response by many businesses has been to postpone new investment. Data from the Bureau of Economic Analysis, part of the Department of Commerce, states business investment in equipment grew by 8.5% in 2017 and 5.0% in 2018, but it declined at an annualized rate of 0.8% in the first three quarters of 2019.
Exports have also taken a hit. After a 5.5% increase in 2017, the growth of exports slowed to 0.4% last year, and exports have fallen at an annualized rate of 0.2% in the first three quarters of this year. Bureau of Economic Analysis data through August show goods exports to China down $14 billion, or 16%, from the same period a year ago. Imports from China have fallen $43 billion, or 12%, from a year ago.
The manufacturing sector has been especially hard hit by the slowdowns in exports and business investment in equipment. The number of manufacturing jobs grew by 188,000 in the first nine months of 2018, but only 36,000 in the first nine months of this year, according to the Bureau of Labor Statistics.
The tariffs also have bit consumers in the wallet. For the more recently introduced tariffs, the full effects on consumer prices have yet to be felt. It is instructive to look at one of the earliest tariffs applied—those on appliances in the first quarter of 2018. The Consumer Price Index (CPI) contains an index that measures prices for major appliances. Generally, the price index for major appliances has been falling—by 4.1% in 2015, 5.9% in 2016, and 2.6% in 2017. The decrease reflects the fact that appliance manufacturers have become more efficient and have passed on their lower costs of production to consumers. Also, they have improved the quality of their products, and the CPI data are adjusted for quality improvements. In 2018, however, the price index for major appliances rose 9.1%, a sharp break from the previous trend which saw prices falling about 4% per year.
In a tit-for-tat trade war with the U.S., China is at a disadvantage since it exports much more than it imports from the U.S. Yet, gross domestic product (GDP) growth has slowed only slightly in China from 6.8% in 2017 to 6.6% in 2018, and 6.0% in the third quarter of 2019 on a year-over-year basis, according to the International Monetary Fund. To a large extent, this reflects an aggressive use of fiscal policy to offset the economic drag from the trade war. Meanwhile, the Congressional Budget Office reports that the government deficit has risen from 3.9% of GDP in 2017 to 4.8% of GDP in 2018, and is on track to slightly exceed 6.0% of GDP this year. The central bank has also cut interest rates. Policy has followed a similar pattern in the U.S., with the Federal Reserve easing monetary policy three times this year and the deficit in fiscal year 2019 rising to 4.7% of GDP from 3.9% in fiscal year 2018.
A major motivation behind the tariff war has been concerns about China’s practices concerning intellectual property rights, including trademark infringement, theft of trade secrets, and use of foreign-ownership restrictions to force American and other foreign companies to share technology and knowledge with local firms and partners. China has acknowledged that it needs to improve its protection of intellectual property rights and has pledged to step up the enforcement of its laws. While China has been making some progress, notably in the areas of patent and copyright protection, overall legal enforcement of laws on intellectual property remains weak.
It should be noted that China’s economy would probably benefit from better enforcement of these laws and general improvement in the rule of law. Many companies have undoubtedly limited their investment in China because of those shortcomings. Credible improvements in this area would lead to a new surge of foreign investment in China.
The concept of rule of law (including how it relates to enforcement of intellectual property rights) has run up against a difficult reality in China, which is that the overall legal system remains a tool through with the state exercises political and social control. While the Communist Party has offered rhetorical support for the idea of rule of law, the concept in China has a somewhat different meaning and is constrained by the reality that law is subject to the leadership of the party. Given that many Chinese business enterprises enjoy close ties to the politically well-connected, the conflict between rule of law and political control and influence becomes more acute. China has made progress in resolving this conflict and will likely continue to do so, but more due to the evolution of its internal dynamics than as a result of foreign pressure.
Whose Best Interests?
This leaves us with a situation in which American farmers, businesses, and consumers are being asked to make sacrifices to pressure the Chinese government into doing something that is ultimately in the interests of China. At the same time, due to a divergence between the interests of the Chinese ruling elite (who strongly value having a judicial system that functions as a tool for political and social control) and those of the rest of Chinese society, it is likely that China will continue to strongly resist some aspects of these efforts on the part of foreigners to make it reform its legal system.
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